Monopoly Pricing

By Kevin Hinde

Aims and Learning Outcomes  explore price discrimination by monopolists and the potential welfare effects.

 By the end of this session you will be able to – explain first, second and third degree price discrimination using graphical and numerical examples – explain two part tariffs and block pricing.

First Degree Price discrimination P Seller must know each consumers total willingness to pay Pm Ppc Effect is for producer to extract total consumer surplus as a profit

Note: This is better for society than pure monopoly but it does raise distribution questions

MC = AC D MR 0 Qm Q Qpc

Second Degree Price discrimination  Charging different prices based on customer use rates.

 Examples  Buy 2 get one half price  First 100 units at a higher price than second 100 units

P1 P 2 P Second Degree Price discrimination

Note Again: This is better for society than pure monopoly but it does raise distribution questions

MC = AC D 0 Q1 Q 2 Q

Third Degree Price Discrimination  Charging different prices to different types of consumer.

 Examples include: – Geographical price differences – prices aimed at educational and private sector markets.

– Variation in prices between domestic and commercial customers.

 Note buyers in one market cannot resell in another

Some Maths  Assume 2 demands for a big event  Public demand – Qp = 45000 - 200Pp  student Demand – Qs = 100000 - 800Ps  Costs of running event – TC = £1,500,000 + £25Q  Should we charge a uniform price or discriminate?

A Uniform Price  Total Demand: Qt = Qp + Qs – Qt = 145,000 - 1000P  P = £145 - £0.001Q

 MR = 145 - 0.002Q

 MC = 25  Q = 60,000  P = £85  Profit =TR - TC = £2.1 million

A discriminatory price  Public Demand  Pp = 225 - 0.005Qp

 MRp = 225 - 0.01Qp

 MRp = MC   Qp = 20,000 Pp = £125  Student Demand  Ps = 125 - 0.00125Qs

 MRs = 125 - 0.0025Qs

 MRs = MC   Qs = 40,000 Ps = £75 Profit = TRp + TRs - TC = £2.5 million

Third Degree Price discrimination

Note Once More: This is better for society than pure monopoly but it does raise distribution questions

P1 P P2 MC Q1 Q2 Q = Q1 + Q2 market 1 market 2 Total market

Remember that moving from a single monopoly to a discriminating one raises the price in low elasticity markets. These consumers are losing out. So what value should we be putting on their marginal unit of output.

Third Degree Price Discrimination Rule  To maximise profits, a firm with market power produces the output at which MR in each market = Group MC.

 Note too the relationship between MR in each market and elasticity.

MRx= Px (1 + 1) = MC e MRy= Py (1 + 1) = MC e The implication of this is that Firms should charge higher prices in markets where elasticity is low (inelastic) and lower prices in markets with high elasticities

Two Part Pricing  A firm can enhance it’s profits by engaging in two part tariffs  Charge a price per unit that equals marginal cost plus a fixed fee equal to the consumer surplus each consumer receives at this per unit price.

 Examples – Gyms, Golf Clubs

Block Tariffs  By packaging units of a product and selling them as one package, the firm earns more than by single unit pricing.  The profit maximising price on the package is the total value the customer receives for the package, including consumer surplus.

 Examples – six packs, toilet rolls etc

And Finally...

 A summary  Any Questions?